Understanding the Time Value of Money

The time value of money means that a dollar in hand now is worth more than a dollar promised at some future date. This seemingly simple idea underlies not only the concepts and techniques you learn in this chapter, but also the investment formulas in Chapter 18, “Building Investment Formulas,” and the discount formulas in Chapter 20, “Building Discount Formulas.” A dollar now is worth more than a dollar promised in the future for two reasons:

You can invest a dollar now. If you earn a positive return, the sum of the dollar and interest earned will be worth more than the future dollar.

You might never see the future dollar. Due to bankruptcy, cash-flow problems, or any number of reasons, there's a risk that the company or person promising you the future dollar might not be able to deliver it.